The IRS Position On Amway

This is the from an email I received some time ago. One of the
baits that distributors use to lure you into the system is the promise of tax
breaks: "I write off EVERYTHING!" Well, you can do that! You can also
write off everything you buy as a private, non-business-owning citizen as well!
But the real question is, what happens if you get audited?

The Amway business has the appearance of a personal service business.
Personal expenses are disguised as business deductions. The examiner may
not be aware that he/she has an Amway return until the taxpayer and/or
representative is sitting across from him/her. Therefore, it is necessary
that the examiner be alert to possible deceptions.

AREAS OF DEVELOPMENT

Sections 162,183, 262, 274, and 280A of the lnternal Revenue Code should be
considered when examining an Amway return.

Section 162 allows ordinary and necessary expenses paid or incurred to
carry on any trade or business. The word "reasonable" should be inferred by
the examiner when considering "ordinary and necessary."

Section 183 addresses activities not engaged in for a profit. Deductions of
these activities are limited to the gross income derived from the activity
and ordinary and necessary (and reasonable) expenses in accordance with
section 162 and section 212.

Section 252 specifically disallows personal expenses.

Section 280A addresses office in home limitations.

Section 274 specifies substantiation requirements.

Three court cases upholding Section 183 for Amway returns are (1) Ranson v
Commissioner (2) Elliot v Commissioner, and (3) Rubin v Commissioner. These
cases all involved selling Amway products at retail. Taxpayers may have the
potential to make a profit provided they conduct the activity in a business
like manner and do not deduct unnecessary trips and personal expenses. As
can be seen in the above mentioned cases, the taxpayers did not conduct the
activity in a business-like manner and deducted personal expenses. These
cases may be helpful in developing the Section 183 issue.

DEVELOPMENT OF THE AMWAY CASE

Business history should be developed and documented in the examiner's
workpapers. (See Figure RS 3-1 from Unit III Tax Auditor Distributorships
Workshop for examples of questions to ask.) If Section 183 is indicated,
the examiner should obtain copies of the prior year Schedule C's from the
inception of the activity. These should be summarized by (1) sales (retail
and wholesale should be differentiated), (2) Cost of sales, (3) Commissions
from PV bonuses, (4) gross profit, (5} travel and entertainment (including
separately stated items), (6) auto expense and ACRS/MACRS, (7) commissions
paid out, (8) total expenses, and (9) net profit or loss. Also, primary
sources of income should be scheduled (wages and/or primary Schedule C,
Etc.), to illustrate the offsetting of income by personal expenses. Each of
the nine factors of Section 183 should be developed.

GROSS INCOME should include gross receipts less cost of goods sold and net
bonuses (bonuses received less bonuses paid). Cost of Goods Sold should be
reduced by personal use items. If a taxpayer has purchased enough personal
items to qualify for a discount, then the purchase discount on personal
items should be removed from income for any given month to which the
"bonus" would apply: Some taxpayers may include personal items purchased in
gross receipts and cost of goods sold to give the appearance of more
business activity than actually exists. This distortion is for the purpose
of making expenses appear more reasonable.

TRAVEL AND ENTERTAINMENT have always been areas of abuse. Sections 162,
262, and 274 are always applicable and sometimes Section 183. Since most
of the travel is primarily to attend social gatherings for entertainment
and motivational purposes, any real business purpose is suspect. Unless the
taxpayer can show that attending seminars, meetings, etc., meets the
requirement of Section 162, the travel should be disallowed. Amway people
have been unable to show that attending these meetinqs increased their
sales. The agendas of these meetings appear to be primarily for
entertainment, socializing, and listening to motivational speeches. The
meetings have nothing to do with promoting the sale of Amway products to
the general public. In fact, Amway distributors are specifically warned
aqainst
mentioning either Amway or selling when recruitinq potential downline
people. Since it is not likely that the taxpayer will increase his sales by
attending these functions, then there is not a reasonable business purpose
for the trips.

Amway people frequently deduct MEALS AND GIFTS to friends and relatives as
business expense. There is little justification for entertaining one's
downline or potential downlines. This is one area where documentation is
lacking. In some cases the entertainment is reciprocal. Most people
entertain their friends and relatives; therefore, this is not an ordinary
and necessary expense. Gifts are frequently disguised as "advertising" or
"promotions." The examiner should be alert to these ploys. Amway people
frequently deduct their own meals when attending local meetings with other
Amway people. {See RIA L-5805, the "butter" rule). Local meals are not
allowable.

CAR EXPENSE is another area of abuse. Occasionally, the taxpayer will
deduct commuting expense to his primary job claiming that he is going to a
second job since his Amway business is located in the house; however, this
is rarely seen anymore. An Amway distributor usually picks up the products
from the upline once a week. Once a certain volume of purchase is reached,
the distributor may purchase products directly from the company.
Transportation
expense related to picking up the product should be minimal. If the vast
majority of purchases is for personal use, then the car expense should also
be personal. The taxpayer may incur car expense recruiting other downlines,
but care should be taken to determine if the primary purpose is to visit
friends or relatives. If the taxpayer is selling retail, he may have to
deliver the products. The examiner should be alert to the taxpayer writing
off trips to visit friends or relatives in distant cities and claiming the
purpose of the trip was to deliver products or recruit. The taxpayer may
also deduct vacation trips. It appears that Amway distributors think that
they only have to mention Amway to make any visit, trip, etc. a deductible
business expense.

When examining GIFTS (under whatever name the taxpayer uses), Section 162,
262, and 274 should be considered. Most gifts are for close friends or
family members and are personal in most cases.

ADVERTISING often includes gifts to friends and relatives. Any
demonstration of Amway products would have a minimal cost to the
distributor and should be well documented as to when, where, why, and who.
The demo products should be kept separate. Using a small sample of a
product for demonstration and then using the rest for personal use is a
personal expense.

TELEPHONE EXPENSE is an area of abuse. Taxpayers frequently write off long
distance calls to friends and refatives claiming they were trying to sign
up downlines or sell product. Many taxpayers try to write off their entire
phone bill.

OFFICE IN THE HOME limitation should always be considered. In most cases,
use of the home is not allowed because of the loss. The examiner should be
aware that expenses may be disguised to avoid the limitation.

TAPES, TOOLS, ETC. are a few of the categories used to write off
motivational tapes and baoks. Most of the tapes do not have anything to do
with selling Amway products. Unless the taxpayer can furnish specific
information showing the tapes or books are for the purpose of promoting
and selling the products, they should not be allowed as a business
deduction. The taxpayer should have a list of all tapes, books, etc. used
as an expense on his/her return. As with all Amway products deducted as an
expense, the examiner should verify these items have been removed from
purchases in the Cost of Goods Sold. It is not unusual to find these items
deducted in both places. (See Exhibit B for list of tapes and books.)

Your Amway Business When You Are Below Direct

When you first begin your Amway business, you can expect to show a loss on
your tax return for the first couple of years. As your business grows, your
loss will decrease each year. Usually by the time you reach Direct
Distributor, your business will then show a profit on your tax return.

What is a loss and who does it affect you and your taxes? A loss simply
means that you have spent more money thatn you have made in the business
during the year. With your Amway business, you have many mileage deductions
which are also expenses for your business. The actual out of pocket money
you spend on your business, and your mileage deductions go on your tax
return as business expenses. In the first years of building your business,
these expenses will be greater than your income; therefore, your business
will have a loss.

The IRS realizes that it takes time to make a new business profitable. The
IRS give you the first two years in business before it expects your
business to become profitable. This is a great advantage for the Amway
business.

A loss reduces your taxable income and reduces the tax you pay. In other
words, the biger your Amway loss, the larger your tax refund will be.